What Is A Credit Building Loan?

Loans & Credit BY Ankita Feb 02, 2024
Credit Building Loan

Throughout life, we can often make poor decisions regarding our finances. Perhaps you underestimate the effect that late payments have on your credit score, or maybe you bit off more than you could chew with a high-interest loan. Whatever the case is, everyone is prone to mistakes, and we firmly believe that nobody should be punished beyond all hope for making a few financial mistakes.

This is where credit-building loans come in. They’re a financial product designed to help people establish or improve a credit history. Credit-building loans work a little differently from regular loans, and they’re also regulated to prevent people from being financially abused. So, let’s learn more about credit-building loans and if they’re right for you.

How Does A Credit-Building Loan Work?

How Does A Credit-Building Loan Work

Credit-building loans work similarly to regular loans. You borrow a set amount of money, and then you’re expected to repay it over a set amount of time. As long as you make payments back on time, your credit rating will slowly begin to increase as it shows lenders that you’re capable of sticking to your credit agreement and terms.

A credit-builder loan lets you make fixed payments dedicated toward a savings account for several months. Once the term ends, the lender is most likely to pay you back the account balance. Most probably, this takes place for the interest you have paid. Furthermore, you will have to strengthen the credit with a positive payment history.

Who Are Credit Building Loans For?

Credit-building loans are for people who are looking to build or repair their credit history. Having a poor credit rating typically prevents you from accessing certain financial services, such as a mortgage or car financing. By increasing your credit score, you’re more likely to be considered for these services in the future.

However, it’s worth mentioning that credit-building loans are intended for people who have low credit scores or no credit history. If you’re already able to take out loans from your bank or other financial institutions, then it’s generally considered a better idea to use existing services as they offer better interest rates and higher loan amounts.

How Much Can I Borrow With A Credit Building Loan?

How Much Can I Borrow With A Credit Building Loan? 

Credit-building loans offer smaller sums of money compared to other financial products. The amount can vary based on the provider or your financial circumstances. Typically, credit-building loans will be around the £100 or less range but can go up to the thousands if your circumstances allow for it.

Repayment terms are flexible, just like other loans. They can start from just a couple of months and go to several years if needed. As a form of installment loan, these credit-building loans can provide you with a good sum of monthly payments. Hence, repaying them on time leads to a healthy credit score as the payment history affects your FICO score by 35%.

Not only do they help you restore your credit but also make a good credit impression by removing negative marks on the report.

Are Credit Building Loans Different From Regular Loans?

There are a couple of ways that a credit building loan is different from a regular loan.

  • In many cases, a credit-building loan doesn’t give you money until you’ve made all of the payments. This is different from regular loans, which provide you with the amount upfront. The purpose is to prevent people from using credit-building loans as a form of bad credit loan, which would normally have a very high-interest rate.
  • Secondly, a standard personal loan operates well by offering a lump sum funding to the borrower right when the loan term begins. On the other hand, credit-builder loans offer borrowers capital when the term is about to end. Apart from the amount, time management is also a big factor in these categories of loans.
  • Thirdly, a personal loan has the amount you need to pay off over time. This might seem a little too hasty but it ultimately gives you peace of mind. However, credit-builder loans have a lump sum which is stored in a different account- right after all the terms are addressed.

Are Credit Building Loans A Good Idea To Increase My Credit Score?

Credit Building Loans A Good Idea To Increase My Credit Score

If you’re able to afford the regular repayments then credit building loans can be a great way to establish a credit history or to build up from a poor credit rating. However, this only applies if you’re unable to get a personal loan or any other financial product that has a lower interest rate and better terms. If you’re able to set up a loan with other methods, then there’s typically no need to take out a credit building loan.

There are also other ways to build up your credit score, such as using a credit builder app like Credito. You can also pay your bills and other regular expenses on time to ensure that your credit score doesn’t drop.

In some cases, you might be denied a credit building loan application. However, this won’t be due to your credit history or lack of one. Instead, it’ll typically only happen if you’re unable to prove that you can afford the loan.

Conclusion

And that marks the end of this comprehensive guide. But before ending, let’s summarise what credit-building loans are:

  • Designed for people who want to repair or improve their credit rating, but have trouble being approved for a regular loan.
  • Loan amounts are typically smaller than other loans.
  • Depending on the provider, you might only receive the funds after making all of your repayments.
  • Still have to prove that your financial situation is stable enough to repay the loan.

Credit-building loans can be a great way to reverse the damage of older financial decisions, or even just to establish an early credit history. However, there are many other ways to repair your credit history, too, so you can consider this as one of the many ways to improve your financial standing with lenders.

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Ankita Tripathy loves to write about food and the Hallyu Wave in particular. During her free time, she enjoys looking at the sky or reading books while sipping a cup of hot coffee. Her favourite niches are food, music, lifestyle, travel, and Korean Pop music and drama.

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